Walgreen's Management Hosts Analyst Q&A Conference (Transcript)

Wade D. Miquelon - Chief Financial Officer, Executive Vice President and President of International

Analysts

Eric Bosshard - Cleveland Research Company

Rita Spitz - William Blair & Company L.L.C., Research Division

Edward J. Kelly - Crédit Suisse AG, Research Division

Herbert C. Blutenthal - Hartline Investment Corporation

Mark R. Miller - William Blair & Company L.L.C., Research Division

Mike Otway - Jefferies & Company, Inc., Research Division

Stephen V. Tanal - Goldman Sachs Group Inc., Research Division

Nell Geiser

Walgreen Co. (WAG) Analyst Q&A Conference January 9, 2013 5:00 PM ET

Question-and-Answer Session

Rick J. Hans

Okay. So Wade has arrived. So we will begin the Q&A session. And so just raise your hand, please, and Nick will come around and hand you the microphone. Go ahead and identify yourself, if you don't mind.

Eric Bosshard - Cleveland Research Company

Eric Bosshard, Cleveland Research. Interested in -- you bought drugstore.com, I don't know, a year ago or a few months ago -- so interested in what you're doing with online, what you see in terms of online competition. It appears Amazon's pursuing, obviously, lots of other retail categories with the success of yours, it would appear to be one that has gotten some exposure. Just interested in online penetration, your category and how you see yourself participate in or being impacted by that.

Wade D. Miquelon

Okay. I'll say some brief things. Obviously it'd be great if someone who was here should go into much more detail. I think, first off on drugstore.com, that acquisition for us is ahead of what we would call booklet. So it's exceeding our objectives. So in terms of revenues, profits, et cetera. I think it's also been a great catalyst for us to just to not only learn and expand the market, but to do some longer tail things in prestige beauty and other things that we couldn't otherwise do in our stores.

I would say for us, the online or, let's call it, multi-channel, omni-channel, whatever you want to call it, there is probably 2 kinds of vectors of opportunity. One is just making it part of a ubiquitous experience. So a huge percent of our scripts are now ordered via mobile or online, which simplifies things for us and makes it easy for the patient. Just the amount of information that people are using, the way we're building our health information systems, our HITs and others, to be able to interface how, now that mobile apps with loyalty is now providing easy access ability to redeem points and probably ultimately mobile wallet and a variety of things. So I think that the e-commerce team is doing an awesome job, making it kind of an enabler to the whole experience.

And then there's the e-commerce sales directly, just order online, deliver to home. That business has been growing very nicely. I don't know we've given statistics, but I'd say we're not different than others.

I think the big frontier for us though, and we've alluded to it a little bit is, there are some opportunity for us, I think, to combine our physical assets with the online assets to create an experience and things that are not going to be replicatable by someone who is just a brick retailer or someone who is just an online player.

So we've done some various pilots and other things. But I think for us, ultimately, becoming ubiquitous, being able to use all of our assets and surround people when they want, where they want and how they want it, is an interesting play. I mean, when you think about it, actually our stores in a way are like having 8,000 DCs if leveraged correctly. So we're looking at lots of different options there.

Unknown Attendee

Gross margin side of things. So obviously, a phenomenal gross margin quarter. It would seem like you're positioned well given where the generic wave is right now for the next quarter or 2. Is that right? Is that the correct perception, sort of, in the near term? And then as we look into now lapping what's going to be this wave this year, should we expect gross margins to be down just because of the dynamics and the way that the generic cycle plays out?

Wade D. Miquelon

Well, I think our gross margin percentage is probably going to increase for a long time just because of the mathematics. We make a higher gross margin percentage in generics than we do on brands. But remember, the way we look at it is gross profit dollars per script. That's really -- that's kind of what these reimbursement disputes have been about, which is we run all the brands, generics, everything through a sausage grinder. We get to what we think is a fair dollars per script. And if we get that, we don't care exactly how we get there.

So with generics, we're going to have a lot higher percentage than you would with branded. I mean, I've said historically, the branded average, gross profit on a $200 script for the industry is $7 or $8, versus generics on a $25-ish might be $15.

But having said that, I think that our gross profit dollars per script is -- we've never had a better commercial book for the very long term. And even past the generic wave, we've structured ourselves in a way that I think that we're going to have a very stable leg for a long time. That might have meant that we gave up a little bit of upfront gravy in terms of how we think about corridors, et cetera. But again, I think that our business, even past the generic wave, is going to be able to earn very solid gross profit dollars for as far as I can predict. So I don't ...

Unknown Attendee

[indiscernible]

Wade D. Miquelon

Well, our model is if we can have remotely stable gross profit dollars per script, because the way we're driving efficiencies, is we can be very successful financially. And historically, we had probably a few pennies per year creep through branded inflation and other. But for the past couple of years, it's been more of kind of stable. But having stable for us, the way we can drive, again, efficiencies, it works for our model and for, I think, the expectations that people have. The key is just not having the bottom fall out. And I think that part of the reimbursement dispute was exactly about that, where you've had one payer who wanted to pay dramatically less than the rest of the market. And as soon as you do that, then every other payer says, "Well, why shouldn't we get it as well?"

Unknown Attendee

[indiscernible]

Wade D. Miquelon

I would argue you are probably more on a PBM phase versus our phase because of the way we design long-term quarter pricing contracts, which means that PBMs might get a little bit more gravy in the middle of the spread than they would otherwise. But longer out, in the multiyear agreements, it's going to be better for us. I can't speak to how other retailers have structured it, but that has been a strategic choice we've made the last few years.

Rick J. Hans

Just for a little history on this thing, John. We've actually been content with the fact that our gross profit dollar per script has actually grown every year for the past 10 years. But it only grows a little bit. We're satisfied with a matter of penny increases. And then we try to fill more scripts every year. So we don't get these dramatic swings in the gross profit dollars per script. You may see some shifts in the margin percentage, but you don't get a dramatic swing in the dollars per script. And if you're trying to think back to 4Q '07, that was not an issue of gross profit dollars per script falling apart. That was just an issue of SG&A...

Wade D. Miquelon

SG&A getting out of line. I hope that helps.

Rick J. Hans

Who's next?

Rita Spitz - William Blair & Company L.L.C., Research Division

Rita Spitz, William Blair. I wonder if you could go back to the first question in terms of the online and talk specifically in terms of brand control and whether or not you have the authority and right to sell any brand in your store on the website or not. Are you finding that there are restrictions or [indiscernible]?

Wade D. Miquelon

I can't think of any restrictions we have specifically. There are some things we sell online that we can't sell in-store. For example, there are some very high-prestige beauty items, high-prestige beauty, until you have the experience that feels commensurate with it, whatever, it's difficult to get it into retail. But that's been something we've been [indiscernible] on with LOOK Boutique and others.

But in general, that's not an issue. Part of the key challenge is to try to manage pricing, right, because for us, we do have various pricing zones. So we might have one zone with either -- maybe a different competition or other zones that are just in very expensive locations where you might have a different price in one store versus a store across the country, and then with the online environment, how do you manage that?

So that's probably the trickiest piece. But I would say, in general, what's available online can always be available in-store, but it -- in-store or online, but not always the other way around, especially with things like prestige.

Edward J. Kelly - Crédit Suisse AG, Research Division

Ed Kelly, Credit Suisse. Wade, could you maybe talk a little bit about what's going on, on the front end? And more color on December in particular, what you saw out there around holiday? Comp was obviously pretty weak, but you had a flu benefit, so it does seem like things ticked down further.

Wade D. Miquelon

Yes. I think it's -- I don't think it's any funkier in December, really all-in, than it was in kind of call it September, November. Like I said, we had a couple of shifts. One is we did lose some, although modest, front-end from Express Scripts. And then we had this promotional shift. And then we had, remember at one point in time, we were enrolling 200 people per store per day in loyalty, while we were winning back new Express Scripts customers, while all of our competitors were trying to drop the kitchen sink on us to try to retain. I'm very confident moving forward. My own belief is that we've got a lot of underpinning strength. Not only are we going to get some benefit from Express, we are going to cycle this promotional thing. And right now, we're getting into a phase where 50 million people have loyalty cards and about 50% of our sales are coming through that. And we're getting a critical mass of people that are now hitting redemption phase. Plus, I do think the underlying things we're doing are better than what we were doing in '11, when we were out comping people by a couple hundred basis points.

So my own point of view is to stay the course. I think that our team has made a strategic choice the last 9 months to balance profitability with growth. Maybe we could have been more aggressive on promotions and other things, but I'm not sure that we would have been any better off, and in fact, maybe we would've put some good money after bad. But I think moving forward, with all the things we're doing and the cycling, that we're going to be able to have a good story in growth and margin. That's my belief.

Rick J. Hans

Yes, I think you're right. I mean we did have a soft red and green this Christmas. And to your point, we did get the benefit of cough, cold on the front end, so that would probably magnify the impact of red and green. But it was tough, no doubt about it. But it is seasonal stuff, and we do cycle out of that, too, so that'll probably be a bit of a tailwind for us next year.

Wade D. Miquelon

Over time, we might see -- maybe we see that in some of the seasonal holidays, Christmas and stuff, we just don't have the pop we used to because we're not dedicating multiple aisles. You have online Black Friday, Cyber Monday, whatever. But I actually believe that every other day of the year, we're going to end up being stronger than we ever were before because we're going to be more relevant in our offerings and more linked to our equity. So I think the last couple of years, we've seen a little bit of that. Like take Halloween, for example, where there's -- just drive down the street and there's 6 part-time warehouses and stores set up for Halloween sales. But look, if we're a little bit less on Halloween and Christmas but every other day of the week we're going to be that much stronger, I think that, on aggregate, we'll be a lot better off.

Edward J. Kelly - Crédit Suisse AG, Research Division

Any margin issue to think about post-holiday, given the sales?

Wade D. Miquelon

No. I think we are on a progressive march to keep improving margins. Jason here is not only our Treasurer, he serves as CFO, and all the CFOs of the businesses report to him, so Jason is close to it every day. I don't know if you have anything you want to add or if you feel that what I've said is pretty much...

Unknown Executive

[indiscernible]

Wade D. Miquelon

I'm extremely confident in front end. I think we're doing all the right things. And I think it's going to pan out that way. And I think we just have to ride through it a little bit, but I think that you're going to see that we're doing all the right things.

Edward J. Kelly - Crédit Suisse AG, Research Division

All right. And just a second question on SG&A. In Q1, you made investments in staffing and marketing for Rewards, Express, Part D enrollment. How do we think about that as we progress through the year? Does that continue in the same intensity in Q2? Your comparisons get tougher as you move through the year?

Wade D. Miquelon

Balance Rewards, Part D and Express were all, I'd say, sort of temporary phenomena. Part D is, whatever, 1.5 months of enrollment. We've enrolled 50 million people on Balance Rewards. So the pace by the day is going to go down, default, over time. And with Express Scripts customers, I guess we'll keep enrolling every single day, but you don't have the initial 30-day craziness blitz. But I think if you look at it at a normalized basis in the first quarter, I forget the exact number, I want to say around 1.5% or something. If you pulled out, not only do the adjustment, but you pulled out the incremental 100 and whatever basis points for that, I'd say I think I'd guide to our sustainable model, which we've said that over time, organically, we're kind of looking to have 3.5% to 4% -- 4.5% kind of as an organic average, of which about 150 is driven by new stores and the balance is other things we're doing. We will have -- like right now, we have USA Drug. I don't know, it's probably almost 100 basis points in there year-on-year, so you pull that out. But if we can get to that sustainable model of the organic 3.5% to 4.5%, I think we're going to have that gross profit dollar versus SG&A dollar and a very, very good story to tell.

Rick J. Hans

Yes, Ed, it's imperative that you look at SG&A dollar growth with respect to what we did a year ago, because of the first half of the year is dramatically different than the second half of the year. SG&A dollar growth in the first half of the year last year was 4% to 5%. SG&A dollar growth in the latter half of the year was minus 1% to minus 2%. So you're going to have that shifting this year, too. I would look at 2-year stacks to some degree.

Unknown Attendee

[indiscernible]

Rick J. Hans

Yes, because you're up against a minus 2%.

Wade D. Miquelon

So I don't think there's any chance it will be out of control.

Rick J. Hans

Yes.

Wade D. Miquelon

Right. Plus you're going to have things -- I mean, assuming we hit all of our stretch goals and things like that, you do pay, you have a little more profit sharing, you pay more bonuses and those kind of things. And those get accrued throughout the year, but you never know. But if you have a successful year and hit all your objectives, then you're glad you had that.

Rick J. Hans

[indiscernible] I'm sorry, Nathan. One at the back here.

Unknown Analyst

Matt Demetrius from South Street Capital Management. [ph] On your private label strategy, can you just talk about the mix across the various private label brands? Is that going to be consistent across stores? Or have you got a strategy to kind of vary that based on whether it's a flagship store, take demographics of the market, et cetera?

Wade D. Miquelon

There is a whole architecture -- I think we've gotten -- in the last -- it's probably something we haven't even talked about enough, but the last couple of years, [indiscernible] and his team has taken us just light years into the future. We've always had a pretty good business of what I call compare and save. It's only been around 19%, 20% historically. But it's been around more ibuprofen, Walgreens brand that you can trust 20% less or whatever. And across store, we're very good at that. What we've been doing in the last 1.5 years, 2 years, in the last 3 to 6 months is really accelerating, what I'm going to call differentiated offerings. So if you've seen the Delish line now across the broader offering, you'll know the products -- in many cases, they win taste tests versus the branded, there are items that you can't even find in branded, very differentiated. So I think you're going to see not only will we have different categories, good, better, best. You're going to see that we're bringing out more brands that are differentiated and completely unique to Walgreens. With respect to the whole franchise, I think you're going to see Delish and Nice! in Walgreens, whatever, in almost every store to a different degree. One of the big differences might be, with respect to like, beauty. As you know, we just launched our pilot store No7. It's off to a very successful launch in L.A. But over time, making that a national brand at Walgreens, at our probably our higher-end stores, is a huge opportunity. It probably won't end up being everywhere. But when you get into beauty, it's a completely different ballgame. And the experience, as you know, in terms of whether we can afford that location, testers and consultants and all that, is all relevant. And so that's probably the one exception.

Unknown Attendee

[indiscernible] You were alluding -- and during the meeting it was also alluded that margins are going to go up in the front end, partly because of the mix change and private label, and one thing or another. But can you comment a little bit about the difference in profitability in some of these areas, the way you did about generics versus branded? And could you also please give us some idea how extensively you can roll out the cosmetics boutique throughout the company?

Wade D. Miquelon

A couple of things, I guess would say, is that as a general kind of construct, even though we make most of our profit in the pharmacy, an incremental sale in the front end is more valuable than the sale of the pharmacy because we have a higher gross margin, and a private brand offering is even more valuable than that. That's kind of the hierarchy of order. I don't know if I said explicitly that we expected margins to go up. What I did say is that 8 of the last 9 quarter they've been neutral or going up. And I think that we do have opportunities, as we drive private brand, as we drive Health & Beauty mix and some of the other efficiencies, I think we do have opportunities there. We haven't been explicit, but I think that the team has done a -- and I think also things like the Balance Rewards loyalty program allows us to shift all of our dependency from roto, which is 60 million people a week, very expensive proposition, to a very balanced holistic offering, where we can target in on the most loyal customers and reward them to drive a much bigger basket. And we are seeing basket improvements there as well. So we definitely have opportunity. I just -- I've got Joe here, so [indiscernible] supposed to be explicit if we weren't explicit. But we have opportunities on that.

Unknown Attendee

Can you talk a little bit about the mix? I mean, are you going to -- the pharmacy is roughly 70% of the business. I mean, do you expect to see that go down in the future?

Wade D. Miquelon

I don't think that our pharmacy is going to be any weaker. But we may have opportunities over time to grow our front end...

Rick J. Hans

I think pharmacy as a percent of sales could fall. Mostly because of the generic wave, right, because sales are so much lower [ph]. So it's not something we target. We try to sell as much in the pharmacy as we can and try to sell as much in the front end.

Wade D. Miquelon

But the relative units, I would say, probably there's no reason to think that we can't have balanced growth in those channels.

Unknown Attendee

One of the other things that strikes me with your rewards program is whether or not you can really get into personalization in the front-end customer as well as the pharmacy. Like say you're running out of mascara or something or other, and jog your memory and get them back in the store for something. And knowing the customer is better the way you're already doing with pharmacy.

Wade D. Miquelon

For sure. And I would say the team that we have, that we brought on board, led by Alan -- Adam Holyk is, in terms of the analytics people, have come from [indiscernible] Shoppers and a variety of others, Ipsos, whatever, are really world class. And what we're learning every day about insights about our customers, who they are, the most valuable, what they prefer, whatever, are insights we've never had before. So at the end of the day, loyalty is about motivating your most -- rewarding your most loyal customers and finding others like that. And I think just now, we're starting to really see the power of it. I mean, when you're signing up 200 people a day per store, and they're gaining points but they can't use points, it's not a lever. But when you have 50 million, 60 million, 70 million, and you have millions of people that can redeem and redeem in a big way, and you have their information and you know what they might prefer, that's where you get the benefit. And I think we're just now entering into that phase.

Rick J. Hans

And I think the word-of-mouth phase, we haven't gotten there yet either. When people start redeeming points, and get excited about it, they'll talk to their friends about it.

Herbert C. Blutenthal - Hartline Investment Corporation

Herb Blutenthal, Hartline Investments. With Jim Skinner's background at McDonald's, where they expanded around the world a lot more than in the U.S. in recent years, do you see him as having an active role of guidance, working with Boots or on Walgreens name, using Walgreens name, to go into some of these other countries, since McDonald's has had exposure all over the world, it strikes me that he could be a major contributor if he is to be so used.

Wade D. Miquelon

I mean, Jim's obviously a great resource and a business mind. I just would say Jim's style, I think, is that I would say is that governing right, is you've got to empower management to do what they say they can do. And if management doesn't do it, then you get new management. I think that's kind of how he -- which is I think is the right way to view it as a board member. Having said that, I think he's a great resource. I think he's offered up a lot of international resources for us and varieties. But I think in terms of whether it's Boots or Walgreens or what countries, I think that he would say and we would say that you have to let the data prevail. In many countries, Boots has great resonance and a great history. And if you were to go there, that would be the logical brand to lead with. In other countries, Walgreens might be more. But I think that he would trust that we would use the data and the analysis combined to do the right thing versus kind of actively getting involved in managing that.

Herbert C. Blutenthal - Hartline Investment Corporation

My question wasn't just whether it's going to be under the name Boots or Walgreens, but rather do you see him having an active role in deciding which country is next, which continents? And he certainly, through McDonald's experience, which is site -- location, location, location, he knows the importance of sites, as you guys do. Could he make -- would he be making possibly a major contribution to the people who are going to go taking you into other countries or is he going to be more chairman, overseeing and not get into the nitty gritty?

Wade D. Miquelon

I think he'll contribute in many ways, but I don't think that he'll play a role in that regard, that's any different from the other board members. I think, by their nature, the board is collegial. They want to hear what management has to say. It they have a different point of view, they'll air it. So I'm not suggesting we wouldn't use him as a resource, but I think that he would first and foremost expect that our leadership, Alliance Boots leadership, use the data coupled with analysis and then recommend it. And if anybody in the board has an issue, we want to address it and understand.

Rick J. Hans

I think you can tell that he's not afraid to share his opinion.

Wade D. Miquelon

But the model is different. The franchise McDonald's model and the name is a great model, but it is a bit of a different model than a pharmacy business and whether you lead with pharmacy or wholesale or whatever. I think it's all contextual. Just because one is right for one doesn't mean others. But I think that clearly, as Rick said, if he has an opinion, he'll share it, and we'll certainly listen to it.

But I think to that, or maybe one other things -- I think that he is a very focused person, too, so he would say these 2 or 3 countries, and doing well in those, is worth these 30 [ph]. So make sure that you understand where you're going to pick your battles and where you're going to really win and how you're going to make sure that you don't get too stretched. I think learnings like that, which he's already shared with us, would be very helpful going forward.

Mark R. Miller - William Blair & Company L.L.C., Research Division

Mark Miller with William Blair. Can you remind us why the timeframe of the acquisition was set up as it was, that 6-month period or if they're going out, 3 plus years? Under what circumstances would you and the board recommend moving faster in terms of closing that acquisition?

Wade D. Miquelon

For me, moving faster probably means, at the beginning of the call, 2.5 years versus the end at 3. I guess you could always try to move it forward faster. But right now, we've got lots of multiple streams in terms of not only delivering the synergy, but we're also designing the business model and the various things that go with it and I think that kind of 2.5-ish years has been kind of a very logical timeframe. From a pure financial point of view, I guess an investor would always, if they have a call, would always like the benefit of time. So it's a nice flexibility to have. But we're already 6 months into it. So the first part of the call comes in 2 years. And we're doing a lot of work to design the end-state, like I said, and the synergies and other things. And I think 2 years will be here before you know it.

Mark R. Miller - William Blair & Company L.L.C., Research Division

So it's unlikely that it gets consummated before that timeframe?

Wade D. Miquelon

I would never say never, but it's not going to happen next week, and we're likely going to have a shareholder vote and those kind of things, and those take time to set up. If it was sooner -- would it be a little sooner, maybe. But I don't see it happening in the next 6 months, because of all the practical aspects of things that we need to do and that we're doing.

Mark R. Miller - William Blair & Company L.L.C., Research Division

And my other question was can you remind us how you've developed a forecast for the Express Scripts customer recovery? Was it looking at the plans that you dropped out with CVS Caremark? Or was there another benchmark that you had, to help us understand when you say it's coming back as you planned, what's that relative to?

Wade D. Miquelon

We've triangulated with many plans we've been out of, also with just kind of our -- we've done customer surveys, for example. And we've had some of the employers do surveys, and we've even had employer-by-employer situations that are unique. So we've kind of added it all together and came up with a forecast. And I'd that say it's shockingly on forecast right now. And it doesn't just end right now. You know from history that our win back grows every day for a long time. I've shared anecdotally before what those historic win backs had been. And I would say without being specific here, we don't have any rise to believe that this is going to be any different than we've seen before, right? And I think that the key thing early on is increasing awareness. When we saw early on, 1 in 3 people Express Scripts person that could come back. When you turn it to 2 out of 3 people you double the win back. And 3 out of 3, you triple the win back. That's been one of the key things, is getting that awareness out there.

Rick J. Hans

Yes, I think we have the benefit this year of a heavier flu season. I think that probably helps us because people, generally, they're just not thinking about drug stores like you and I are. They just go back when they need it. And so I think the heavier flu is actually going to be a bit of a driver for that.

Wade D. Miquelon

Anything that drives those acute surges, actually, ends up being a real opportunity.

Mike Otway - Jefferies & Company, Inc., Research Division

Mike Otway, Jefferies. Can you just talk about the Med D plans that you're in this year relative to last year, how material those scripts could be and when that might show up in the front end?

Wade D. Miquelon

A year ago, we were preferred in one plan. That was the first time we'd been preferred in any Med D plan that I know of, and that was the Coventry plan. And now we're preferred in Coventry, in Humana and United. So, and then we are also in a smaller plan, SmartD. It's very material. I don't think we've given estimates, but it's a big needle mover. Part of why we're preferred with Coventry is they had -- their share was not where they wanted to be in the program. They preferred us, they're able to build their share dramatically, and we built our share of their book dramatically, so it was a double whammy. But again, more than 20% of overall scripts being in 3 of the top 4 or 5 plans in a preferred way, if history repeats itself, it will make a difference. I don't know that the front end, as we said before, the front end is kind of a smaller component of the script. Just like Express, we didn't lose much front end as otherwise. I don't know how much we win in the front end or not.

Rick J. Hans

In the pharmacy comp.

Wade D. Miquelon

But the pharmacy comp is where it should be a needle mover. And we won't know all the data until end of January. Because it doesn't get published until then. We started to see people come in now. But even some of them can provide a last fill at their prior before they switch over so...

Rick J. Hans

So CMS will actually publish the data at the end of January, and so everyone will know. It won't be a secret.

Mike Otway - Jefferies & Company, Inc., Research Division

Okay. And then, secondly, in terms of the purchasing synergies, what would prevent, I guess, the -- I mean, since you guys said you're on target for the 100 to the 150 this year. It seems like there's a tremendous opportunity. What would prevent the synergies from coming earlier than the kind of 4 years that you've outlined?

Wade D. Miquelon

What prevents the 100 to 150 from probably being a lot bigger initially is kind of the accounting timing, because those are on a P&L basis. So you might negotiate a better rate. And then you'll order the product, and then it gets shipped and goes into inventory. And it can be 6 months before it's actually flowing through in the P&L. But once you get out a few years, that issue goes away. So look, I think that we put $1 billion out there as not a stretch goal to meet. We said that's the minimum target we want to hit. So if we can do better, we'll try to do better.

Unknown Attendee

I notice you published a report saying you had inside information about that? Do you want to...?

Rick J. Hans

We haven't made any comments about synergies coming in faster or slower than planned.

Wade D. Miquelon

Put a $100 million to $150 million synergies this year on P&L would de facto. I mean, we'd have to live a bit more on a cash basis just because of that timing.

Rick J. Hans

Yes, we'll come back at... Stephen?

Stephen V. Tanal - Goldman Sachs Group Inc., Research Division

Steve Tanal of Goldman Sachs. Just the -- Wade, you had made some comments on a strong commercial book. Could you just flush that out a bit more?

Wade D. Miquelon

Yes. I mean, I -- if you go back, whatever, 4, 5, 6 years ago, whatever, we got an average gross profit rate per script. But if you looked at from the highest payer we got to the lowest payer, it was kind of a bit over the math. Then you had contracts that were very different. Some didn't have any corridors on max, on bids. Some were loosey [ph]. Some were evergreen. Some were rollover. And so our contracting team, the 4 or 5 years, has gone to great lengths, I would say, what's the best way to say, clean up the contracts and try to get better language in, but also get more parity across payers. So the CVS dispute was all about, as they were paying us less than market, and on the renewal, they wanted to pay us a lot less than that. And we said, "No, you're going to have to pay us at market." And we had a meltdown. 11 days later, we resolved it and moved on. Express Scripts was kind of the same dispute, where they were paying less than market, and they wanted to pay us way less than that. And so, what we've done in a way in those 2 disputes is bring the bottom up with -- we have a corridor across all our payers that's pretty tight, very tight in dollars -- gross profit dollars. We brought the bottom up. We also, in some cases, brought the top down. Because we said some other payers that I would say that were probably paying probably a lot more than others were because they were a little bit smaller and because we could. But they were saying, "Hey, if you're giving me a crappy rate" -- sorry my French -- "and if you're giving these guys an advantage, then I can't win the business. And you'll just -- I'll lose my business to them and you'll end up getting that rate anyway." So we've been able to get, I guess, our rate within a tighter corridor across all our payers, very tight. To now where plans switch from plan to plan, we're sort of agnostic. Because as long as we keep the patient, we get the same gross profit dollar more or less. And because of the way we thought about the structuring of the long-term agreements and the corridor pricing, there's not these kind of embedded time bombs, if you will, or dropoffs. It's more of a stable plan. And that's what I mean by -- because when you have a commercial book, let's say you average a gross profit of whatever, $12 or $13 or something, across your whole book, if some people are paying you $7 and some are paying you $20, that's not very stable. But if everybody is within $12 to $13, I mean, that'll provide an ecosystem that you can work with no matter who buys who, who consolidates with who, who loses who to who.

Stephen V. Tanal - Goldman Sachs Group Inc., Research Division

When you talk about multi-year sort of rates and reimbursement, is that -- obviously, on the fill side, I'd assume that's valid. Does that also apply to the ingredient in a lot of instances or not really?

Rick J. Hans

Yes. I mean, it's a -- no, I mean, remember, the gross profit dollars per script is a function of what we get reimbursed versus what we pay for product.

Wade D. Miquelon

But the calculation assumes some level of COGS that you're buying, if you will, right, some branded price. And so, again, we have an estimate of that and we run that through the sausage grinder to say, "What do we think gross profit per script will be across the whole portfolio over time?" And that's where we target that narrow band. And I think we've never had everybody as tight as we have today nor had as much visibility on contracts for the distance [ph] with actual language that is meaningful.

Edward J. Kelly - Crédit Suisse AG, Research Division

Ed Kelly, Credit Suisse. Could you maybe talk, Wade, just about the synergies on the purchasing side from Alliance Boots and your conviction in getting that? And maybe within your answer, could you address some of the issues that you sort of hear out there in terms of pushback, which would be, I think, one, that Walgreens already gets great rates, right? That's what some generic manufacturers are kind of saying. Two, there's differences in packaging between U.S. and Europe and how that plays a role, differences in sourcing regulations by country and what role that may play. And the fact that manufacturers might not be set up to negotiate globally. Can you maybe address maybe each one of those things?

Wade D. Miquelon

The big nugget for drug savings is generics, obviously, versus branded. I don't think we're going to get big discounts across border for branded nor have we calculated any because that's not how it works. With branded, though, we are seeing a lot more opportunity, I think, than we saw before without putting any number on it, in terms of working with them in different ways. So you're seeing big branded players saying, "If you could drive adherence faster or drive a new vaccine across multiple countries faster, help reduce clinical costs, that's worth a lot of money to us." What that would manifest for us remains to be seen. But this is a big opportunity. On the generic side, look, combined in 3 years, we're buying about $10 billion of generics. So if you said that 50% of the billion, whatever, had to come from that, you're talking about a 5% reduction. And I can tell you that on some molecules, where we have the same molecules, same supplier or even domestically where we do that, sometimes the molecules are within a few percent in price. But sometimes, they're 30% or 40% different. Then there's other cases where it's same molecule, different supplier, and you can make some decisions about that as well. But then probably the final piece, which is a big piece, is slightly different molecules or packaging or whatever, same or different suppliers. And I think that the approach here is not to go squeeze blood from a turnip with the vendors. It's really to say, "We deal with 5 or 6 big players in a big way and another 20 or 30 each." And there'll be probably winners and losers. For the ones that want to work with us in a broader portfolio and give us portfolio pricing across all the molecules in a way that works for us, I'm sure it's going to be enough volume for them that they're better off than they are today. And for the ones that don't want to do that, maybe we won't do much business with them. And so it won't be everybody. It will be actually picking and choosing and saying, "Let's work with people that want to have a win-win, and let's minimize business with the others that don't." But those are the 3 levels of what we're working.

Rick J. Hans

Yes, the simple way of looking at it is you can buy a generic drug in any FDA-approved plant around the world and sell it in almost any country around the world. That's the simple fact.

Wade D. Miquelon

Shipping molecules, which is a commodity.

Rick J. Hans

Right. So if I can go in there with triple the volume, I can get a better price. It's as simple as that. Rita?

Rita Spitz - William Blair & Company L.L.C., Research Division

I wondered if you could talk about some of the capital that you're putting into the major flagship stores, like how expensive are those to build? And how many do you need in a market to set the tone for the brand?

Wade D. Miquelon

I don't know if we've said it.[indiscernible]

Rick J. Hans

They're very expensive.

Wade D. Miquelon

Yes.

Rita Spitz - William Blair & Company L.L.C., Research Division

[indiscernible]

Wade D. Miquelon

Sometimes, like the Bucktown store, without giving numbers, right, we put in a fair amount of investment. But we also got a pretty big credit from the developer. A store like that -- there are actually a lot of flagships that you see out there lose a lot of money, but they're considered marketing for the brand. I would say that the flagships we have so far, which is not a million, but the ones we have so far, they're pretty much pulling their weight, right? So we're able to get, I think, great marketing, great innovation, learning. It's a good halo effect. And we're able to do it in a way which isn't losing money. But I don't want people to think the future of the company either as flagships. I mean, one day, will we have 50 or 100 flagships, maybe, but we're not going to have 1,000. And I don't know, maybe Chicago can warrant. Jason, he's here, all over. Maybe Chicago ultimately warrants 5 or 6. Some other smaller cities maybe warrant one. But this is not the core of the business as much as it is, really, a thing that gives us lots of other benefits, it does in a way which allows us to learn, not lose money and provide a halo and an innovation pilot, if you will. The things that we're doing in State and Randolph and Bucktown or whatever, many of those things are being applied to all the stores across the country. But we're able to get it out there and test and learn real quickly. So Jason, anything you want to add?

Unknown Executive

Yes. We don't approach the returns on flagships different than we do expanding our normal store footprint. So we make sure that we're earning a reasonable IRR return on capital on these investments in our flagship stores. And as we talked about, they're a vet for innovation that you can bring across the chain. But we're not lowering our standards and thresholds for these flagship locations. They have to make money, and they have to earn. They have to clear hurdles.

Rick J. Hans

It's a little misleading because they do run tremendous volumes, and the margins are typically a lot higher than our regular drugstore. Just the pricing is higher, a lot of them are in tourist markets, you just -- everybody is priced higher.

Wade D. Miquelon

For a typical store or pharmacy, for us, it takes 3 or 4 years to break even. However, our flagships are probably faster. Now maybe you don't have the ultimate tail where it's really a prescription business and whatever. But you're getting a lot more front-end business upfront. And some of the flagships -- actually the pharmacy business is not as big maybe as a normal pharmacy, but they're in a community serving daily living needs.

Rick J. Hans

I'll add to that. Rita, I do think you make a good point. I think people do fail to realize that there are towns in La Crosse, Wisconsin, that has returns that probably a flagship will never hit. Because you built the store for $2 million and you make $2 million, right? You're not going to get those kind of ratios. But it doesn't mean they're not going to be good moneymakers for us.

Unknown Attendee

Wade, could you talk about the use of cash and even sort of like beyond current fiscal year? And how do you think about CapEx? And you've obviously been doing some stuff around the store base, from a remodel standpoint. And it feels like maybe there's a little bit more to do on that front. And how does that influence CapEx? And then how do we think about the repo, which kind of feels like it's delayed a little bit at this point? Is that a delay until the Alliance Boots deal is done? Or is that just something to think about for the current year?

Wade D. Miquelon

I guess, I'll start with the delay first. And the reason we delayed the repo for the time being is that was basically our agreement with the agencies that -- we want to demonstrate that we're going to meet or beat all of objectives we gave them for Alliance Boots. And in return, we would be diligent in terms of using our cash and not buying back shares. It doesn't mean we'll keep it on hiatus forever. But I think that it was very important for us to keep a very solid investment grade rating and not do anything that would any way jeopardize that. And I think as we deliver results and that plays through, then that's going to give us more and more flexibility. I think we're very committed to dividend and solid dividend growth, as we have been. I think that you're not going to see us change in that at all. We're now into the corridor of 30% to 35%. But if we're able to deliver meaningful earnings growth and you've got our goals in '16, you can extrapolate whatever curve you want. That should mean if we deliver those goals, there'll be meaningful dividend growth all along the way as well. On capital, I guess I'd say, is we made some very heavy investments the last few years in things like IT, I think almost $400 million on our point-of-sale system, which is light-years ahead of where we were and has been a huge boon to efficiency and also to helping with the Balance Rewards card. We probably won't have those kinds of investments. But on the other hand, as we continue on our Well Experience stores, those stores will fill the void, I'm sure, of what we've reduced in terms of the -- some of those one-time infrastructure decisions. So I don't know that you'll see CapEx remotely different from what you've seen in the past, probably a little bit more. But I think that other than that, it's going to be pretty balanced. And I think that where you'll see heavier investment is going to be on the continual refresh as we keep driving Well Experience and learning from that. Jason, I don't know if you want to comment on that either.

Unknown Attendee

Can you give us an update on where the food assortment is relative to your expectations? I haven't recently heard anybody say that it's exceeding your goals. And so -- I mean, has it met your goals? And I guess, what areas are taking a little longer? And has there been any kind of shrink impact? That's what we see often when companies expand into food.

Wade D. Miquelon

Sure. I think the food and the fresh food -- we've always been in food, right? Rick will always say we've been in milk for odd number of years, whatever. But I think it's really more around the fresh initiative and the contemporary foods and some of the -- some of that thing. I think it's doing very, very well. I think the learning curve we've had has been really around shrink and how do you manage shrink. Because when you get below -- there's a learning curve to manage it. When you get below a certain level, there is magic to it. If you're above a level, there's not. And some of that has to do with our ability to manage and learn. But a lot of it has to do with picking the right stores where there's enough volume and frequency, that you don't end up with it and also how you manage it throughout the day. So -- but I think we feel very bullish on the fresh initiative. And I think that you're going to see us continue to march down that path for a long time.

Unknown Attendee

So it is meeting your expectations.

Wade D. Miquelon

Yes. I'd say it is. I'd say, though, but we're rolling it out in a smart, phased way. Because like I said, understanding, a, which stores can warrant more because they have enough volume that you don't end up with shrink. And also helping the stores understand what are the key levers to manage shrink is important. So we're not getting ahead of ourselves. But on the other hand, I think we have every reason to believe that this is part of the future of Walgreens.

Rick J. Hans

There is a little lag, Mark, because you are teaching people that you have fresh and you're going to take some hits while that happens. But I think it's actually moving in the right direction. And of course, there's a huge range. You'll have stores with very high shrink and then some with mysteriously low shrink. And you try to learn from that, too. But we are in fresh, and we are going to be expanding fresh. So I think that sort of says it all. It's moving forward.

Unknown Attendee

Wade, on generics, you talked about how the structure of the contracts has changed over time, so that you're -- I guess you don't make quite as much money in an exclusivity period, but you don't have that big drop and then you don't get killed as you're sort of MAC-ing [ph] later on. But how logistically, as you think about the contracts themselves, how has that actually changed? Could you maybe give a little bit more detail, sorry if this is sort of basic -- how it was historically? How much control you sort of had after the 180 to 1 a day [ph] period in terms of what you're going to make? And then what you did to get yourself to a better place? And how is that actually set up in the contract, though?

Wade D. Miquelon

Yes, Rick will have more history. But I'd say one kind of abstraction for how it's changed a little bit is because the way the PBM industry grew up and the consolidations and all the moves, it's probably no different for a lot of other retailers, is there was a lot of contracts that I would say were kind of like, maybe loosey-goosey is the word, right? They were kind of -- a lot of loose language. And it wasn't clear how much you can MAC [ph]. And it wasn't clear when they ended. And it wasn't -- so it's sort of like a trusting of each other. And then if there was a meltdown, there was a meltdown. Even as I said, probably the Caremark agreement, they had -- we had rates across all of their book. And ones they've acquired, they were all very similar. But they had one that was called the FEP network, it was way below reimbursement for the others. And over time, they were moving our accounts from a fair rate into that network. And we were saying, "Well, you can't do that." And they were saying, "Well, the contract doesn't say we can't." We're like, "Well then, what's the point of having a contract if we have no idea what the rate is and when you're going to move?" And so I would say there was just a lot of all over the board and not as much teeth because it was a sort of trust in the industry back and forth. And as long as times were good, it seemed to work out. We didn't get MAC-ed more than -- I think our contracts now just have more teeth. And so it's clear to both parties what the rights are and there's less of that loosey-gooseyness. I think that's one of the big things. I guess the other difference is that -- I would now say, you never say never, but I think that our contracts -- when it was Express Scripts and it was Caremark, and as I've told you before, they were already submarket, and wanted to go lower. So when you get into these battles, somebody has to swallow the initial nut, right? I think now, I would say, I think our contracts are all pretty close within market. And as we get to the tail end of these things, they'll be more about perpetuating the status quo than around some big showdown. So I think that's also different, is that we don't really have that dynamic in any large way. Rick, do you want to...

Rick J. Hans

I think it's fair. I mean, you really would not have referred to these prior agreements as contracts in the sense that laypeople think about contracts. And because they had -- we basically had the right to -- If we didn't like what they were doing, we had the right to terminate. That was it. And of course, that happened with CVS in Milwaukee and with a few contracts. They just switched us to a low-reimbursement network. We said, "Hey." They go, "If you don't like it, drop on." And that's what we did. When we dropped out of those, we had 1 month's notice to our customers. They really did not like that. That's why when we went back on CVS and when we went back with Express, we did those deals 6 months out. If we don't know what the number's going to be in 6 months, we're out now, we're giving everybody fair warning. So that sort of changed the dynamic of what these are. And I call them true contracts now.

Wade D. Miquelon

That's also why this brand versus generic, single source, multi-source, whatever, is part of the big debate is because they'd say, "Well, hey. We don't want to live with any definition. We'll decide what it is, when it is." And we'll say, "Well, if you're going to pay us 10 for one and 100 for another, then this contract doesn't mean anything." So that was all we ever wanted was to have, I would say, essentially rule of law. So we knew what it was. And if you don't like it, you don't like it. But at least you know what you're going to get. But those are the kinds of things that we've had to try to tighten up, so that they don't have these gigantic holes. And for them, too, they didn't have the surety that as long as they pay you within this, you're not going to threaten to drop out on any given day because that gets stability as well. So I think that, mutually, we've had to find those kinds of agreements.

Nell Geiser

Nell Geiser, CtW Investment Group. I wanted to ask if you could affirm whether the procurement synergies will likely come through in the current joint venture structure regardless of whether the second step option is exercised?

Wade D. Miquelon

I think we could probably get, I wouldn't say all, but we could probably get a significant, a majority, probably, because we're already off and running so heavily on those. I think what we'll leave behind, though, will be a lot of other benefits in terms of some of the top line capability, sharing things we can do in pharmacies to the logistics and all these other things. So procurement, and that's one of the reasons why we did the 2-step, is we thought procurement was low-hanging fruit, where we could get a lot of it early and fast. On the other hand, I think all the vendors we're working with, they pretty much know we're going to become one. And so they're stepping up to work with us because it's just a matter of time. Maybe ultimately, if you say, "Well, it's only going to be an investment, and not going to become one." They might start viewing it differently in terms of our ability to negotiate. So it's hard for me to answer that. I would say, knowing that our intent is to close step 2 makes the purchasing negotiation as if we're one. But if we decided we weren't going to close step 2, we might find some vendors view us very differently on whether they'll work with us jointly or separately.

Rick J. Hans

Did that answer your question?

Nell Geiser

More or less. I would also like to know whether that creates uncertainty that shareholders could potentially contribute to by eventually voting on the merger, and if that's a real, a vote on the wisdom of the deal and shareholders voted it down, and that does create this uncertainty with vendors. So I guess that just raises questions about the tone of these negotiations for the procurement savings.

Wade D. Miquelon

I'd say it this way, right, is we put our goals up there that we believe we can deliver and if we're on track to deliver those goals, I don't think shareholders would want to vote it down. You can run the math. I think it'd be very good for shareholders. If something happened and the whole world changed, whatever, and there was a shift to something we can't foresee at all and shareholders said they had second thoughts, there'd probably be a very good reason for them to have second thoughts. So again, I think as long as we're on track to deliver the goals and do the things that we say we're going to do, I don't know why any shareholder wouldn't be supportive. If things fundamentally shift, well then we'll all have the right to talk about it and people will be able to vote based on the latest and greatest data.

Rick J. Hans

The JV is already approaching vendors as a combined buying entity. So I don't think there's a problem at all with the vendors on this issue. It's a combined buying group right now.

Unknown Attendee

There's no one else. I've been hearing you talk more about performance agreements, in terms of your ability to drive more of this, more of that. Can you expand on how many of your payer relationships have that? Which are the absolute most important of these metrics to you? And how meaningful can that be if you can deliver outperformance versus average performance or less?

Wade D. Miquelon

I mean, the biggest ones we have now, and it's not the only ones, are in the Med D. And we've seen big needle movement, I haven't said what, but very big. I think that -- I think one of the advantages we have and one of the reasons we're being preferred increasingly is because we've been agnostic, by not having a PBM. If you think about United or Humana or whatever, if they're going to partner with a pharmacy, like in Med D, there's really only one option that they're not competing with on the business. I think you're going to see that same dynamic increasingly in other areas, too. So for example, you're going to see in the ACOs and in the individual market, which are going to rise very quickly, is a lot of players are going to say that there's probably some economics for them if they can have a preferred partner who can drive more generic utilization, more penetration, can do free screenings or whatever. And when they pick an anchor partner, they're going to probably look to somebody who they're not competing with head on. And we're one of those 2 options. So I don't think we said restricted networks are taking off. We haven't seen that at all. But the preferred one around performance, I think is, especially in the things that are Med D-like, which is going to be ACOs and individual. And I think that being agnostic gives us a leg up versus the only other 1 or 2 choices.

Unknown Attendee

So just to be clear, it's your generic penetration, you said level of screenings...

Wade D. Miquelon

Well, I would say with Part D, it's things like generic penetration, right, and generic utilization. But I think, for example, with ACOs and even the individual market, it's going to be broader. Because ACOs will be looking at the entire cost of health care. So if you can do a screening and intervention, if you can use a clinic, do a vaccination or other things to reduce the overall costs and improve the outcome on the health care side, they value that almost more than what you can do on the pharmacy side. Because you're talking about a broader proposition, right? So I think that, that's going to be the same concept, but in a bigger way, against all their health care costs and not just the $0.12 on the dollar.

Can you talk about whether Alliance Boots is doing anything to sort of transform the pharmacy into a total health care provider like Walgreens?

Wade D. Miquelon

Because of the NHS in the U.K., they're -- they have a pretty sophisticated system of leveraging the pharmacy. And they see that as a very valuable part of the ecosystem. Even across Europe, pharmacies have been on the front line of health care. So they do a lot of work in not only screenings and vaccinations. They also do a lot of stuff in like in weight management, diabetes, et cetera. I'd also say that they're very big in optics -- optical space, for example, and hearing, places where we can move. So they're doing a lot there. Where I think we're very much advanced, and they would recognize it if they were here, is that our pharmacy systems, for example, that we have in our health -- our HIT systems that integrate into it are probably very advanced and can help them on their journey as they try to do more automation. Even ePrescribe, for example, in the U.K., they have been at it for years, but it hasn't taken the kind of the liftoff that it should. So I think in practices, we can probably share a lot together. And they are ahead in some areas, and we're ahead in some areas. But probably with systems, we can help them improve their business model there.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.